Jun

7

The new auditor’s report in the UK

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audit checklistThere is not a month goes by where you don’t read the words ‘audit’ and ‘reform’ together in the same sentence in some publication or another.  Attempts by regulatory bodies to overhaul the audit regime to make the audit gain more credibility is going to be a huge task given the lambasting that auditors have received over recent years and the way in which the audit profession, as a whole, has been slammed by various critics.

Audit firms themselves have come in for some fierce criticism from their own regulators for failing to adhere to ethical standards or failing to demonstrate professional scepticism (the ways in which auditors can evidence scepticism will feature in an upcoming article for AccountingWEB).  Of more concern is the fact that the Financial Reporting Council has recently reported that the number of audits that contain “serious flaws” has increased from last year.

Aside from attempts to overhaul the audit regime by ensuring auditors adhere to ethical standards and are more sceptical in their approach to audits, the Financial Reporting Council (FRC) have issued an amended ISA (UK and Ireland) 700 The Auditor’s Report on Financial Statements.

Auditors’ reports have also been on the receiving end of some sharp criticism from interested parties.  Technical jargon has been at the forefront of these criticisms because it has been alleged that users cannot understand what the auditor’s report is actually saying.  Some commentators have also criticised the auditor’s report as simply being nothing more than largely describing who is responsible for what when it comes to the financial statements rather than giving any meaningful substance about the financial statements themselves and the audit itself.

The arguments for an overhauled audit report carry much weight.  Indeed I, myself, have been questioned from clients as to what the audit report is actually talking about! In some cases, practitioners have also said that it’s only the Opinion paragraph that is actually looked at by clients because the rest of the report is ‘painful’ to read and clients are lost after the first paragraph.

In recognition of this, the FRC have decided that the audit report needs more substance to it and for audits of financial statements for periods commencing on or after 1 October 2012 there will be more information needed in the audit report.  It is to be noted that these new requirements only extend to those entities that are required to apply the UK Corporate Governance Code.

The revised ISA (UK and Ireland) 700 now requires:

  • A description of the assessed risks of material misstatement that have been identified by the auditor that had the greatest effect on:
    • the overall strategy;
    • resource allocation; and
    • the direction of the audit engagement team’s efforts
    • How the auditor has applied the concepts of materiality in planning and performing the audit; and
    • A summary of the audit scope and an explanation of how the scope was responsive to the assessed risks of material misstatement and the auditor’s application of the concept of materiality as disclosed in the audit report.

Assessed risks of material misstatement

Risk is one of the main features of any audit and the levels of risk essentially dictate the procedures that the auditor will apply to reduce risk to an acceptable level.  Having read the proposal by the FRC in detail, the first question that sprung to mind was at what point does the line get drawn where risk and associated disclosures are concerned?  The revised ISA (UK and Ireland) 700 requires the auditor to describe the assessed risks of material misstatement that had the greatest effect on the audit strategy, resource allocation and how the audit was directed but given the fact that we live in a very litigious world, will auditors be required to disclose all the risks associated with the audit?  Various commentators are recommending such an approach to err on the side of caution and the Application and Other Explanatory Material in the revised ISA (UK and Ireland) 700 at paragraph A13A states that it is left to the auditor’s judgement to decipher which, if any, of the significant and other risks, require disclosure in the auditor’s report.  In addition, where the auditor significantly revises their risk assessment, the auditor must consider the need to disclose this fact, as well as the circumstances giving rise to the changed assessment, in their report.

Materiality

The requirement in the new ISA (UK and Ireland) 700 is to include an explanation as to how the auditor has applied the concept of materiality in planning and performing the audit.  This, at first glance, may appear to indicate that disclosure of the materiality levels are all that are needed to comply with this requirement.  However, the Application and Other Explanatory Material at paragraph A13B is much more detailed and includes materiality that may also include:

  • Materiality level or levels for those classes of transactions, account balances or disclosures where such materiality levels are lower than materiality for the financial statements as a whole (as described in paragraph 10 of ISA (UK and Ireland) 320 Materiality in Planning and Performing an Audit.
  • Performance materiality (as described in paragraph 11 of ISA (UK and Ireland) 320.
  • Any significant revisions of materiality thresholds that were made as the audit progressed.
  • The threshold used for reporting unadjusted differences to the audit committee.
  • Significant qualitative considerations relating to the auditor’s evaluation of materiality.

Audit scope

The audit report now needs to include an explanation as to the audit scope, which also includes an explanation of how the scope was responsive to the assessed risks disclosed and the application of materiality.  The Application and Other Explanatory Material at paragraph A13C does give an example of what may be included in the summary, such as:

  • The coverage of revenue, total assets and profit before tax.
  • The coverage of revenue, total assets and profit before tax of reportable segments.
  • The number of locations the auditor has visited as a proportion of the total number of locations and the rationale underlying any programme of visits.
  • The effect of the group structure on the planned scope.  For example, the group may consist of a large number of autonomous subsidiary companies or may consist of a number of non-autonomous divisions.
  • The nature and extent of the group auditor’s involvement in the work of component auditors.

Initial concerns

A concern that I, and indeed many other commentators and auditors have, is that will the auditor’s report end up with so much information in it that we end up with ‘information overload’ mainly due to the litigious world we work in?  Where do auditors draw the line for disclosure? Will the auditor’s report end up being even more off-putting than it already is?  Of course, the auditor’s report is in desperate need of overhaul to make it more meaningful and the intention of the revised ISA (UK and Ireland) 700 seems to be to allow the user of the auditor’s report to better understand the audit – which is not a bad thing. Some practitioners have suggested that an unqualified auditor’s report needs to be kept as short and succinct as possible without the need for additional information that may confuse users and I think this suggestion has the opportunity of carrying weight.   Notwithstanding the fact that the current version of ISA (UK and Ireland) 700 says that the objectives of the auditor are to form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained and to express clearly that opinion through a written report that also describes the basis for that opinion, the revised ISA (UK and Ireland) 700 now require this objective to be embellished even further with the potential for third parties to question auditors as to their work.

Conclusion

Investors and other stakeholders may well find that information concerning risk, materiality and scope is useful and time will undoubtedly tell if that is the case.  Any improvement to the current auditor’s report is welcome and hopefully the revised ISA (UK and Ireland) 700 will result in more transparent information being communicated through the auditor’s report; although there has to be a balance between transparency and the levels of information contained in the report.

Category: Audit

About the Author ()

Steve Collings FCCA is a director at Leavitt Walmsley Associates Ltd and the author of over 30 books on the subjects of financial reporting and auditing, including 'IFRS For Dummies' and 'Financial Accounting For Dummies'. More about Steve's publications can be found by clicking on the 'Published Work' tab on the homepage. Steve is also a regular contributor of articles for www.accountingweb.co.uk, the UK's largest resource for professional accountants on a free subscription basis. Steve is trained in both UK and Ireland accounting standards and International Financial Reporting Standards and has lectured overseas on these subjects in the Caribbean and Singapore. Steve works closely with various professional bodies developing technical material, including Technical Factsheets and online courses. He has also served on the UK GAAP Technical Advisory Group at the Financial Reporting Council and works with the country's leading publishers in producing material on the subjects of accounting and auditing (both UK and International). Steve was named 'Accounting Technician of the Year' at the British Accountancy Awards and won 'Outstanding Contribution to the Accountancy Profession' by the Association of International Accountants. Follow Steve on X (Twitter) - @stecollings

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